The (Cuisan)art of fiscal policy (Paul Daggett)

Puréeing: Flawed ideas and denial

result in mush that no one can swallow.

StarTribune
July 24, 2011
By: Paul Daggett

The continuing stalemate over whether to raise the debt ceiling and how to control the nation's budget deficits is revealing. Politicians are unable or unwilling to acknowledge the seriousness of the U.S. fiscal position.

Consider the central disagreement between the parties: taxes. The Republican Party opposes increases of any kind, saying that taxes on "job creators" are exactly the wrong policy at a time of high unemployment. To reduce budget deficits without raising taxes, Republicans propose major cuts in government spending.

Democrats contend the huge cuts required to reduce deficits without "revenue increases" would decimate the lower and middle classes, which are more dependent than ever on government's safety-net programs. They argue that higher taxes on the wealthy are a fair way to balance government budgets.

Unfortunately, both parties' positions are fundamentally flawed.

The Republican position that tax increases would destroy jobs fails to acknowledge that spending cuts would also destroy jobs. Cutting government spending destroys the jobs of government employees as well as the jobs of those who sell goods and services to the government and to the recipients of government benefits.

Many Democrats insist that everything was fine with the budget under President Bill Clinton -- the federal government ran a budget surplus in the final three years of Clinton's second term. Undo the Bush tax cuts for the wealthy and end his expensive wars, and everything should be fine, they say.

Clinton's surpluses, however, were the result of a temporary surge in tax revenue as the Internet bubble inflated, not fiscal responsibility.

More important, these arguments both miss the larger point -- the financial/housing crisis and the Great Recession have changed everything.

The crisis has had enormous impact on the federal budget. The various stimulus plans, bailouts, tax incentives, etc., passed in response to the Great Recession cost far more than the Afghanistan and Iraq wars combined. And while federal spending surged at an unprecedented rate, government revenue was collapsing. Federal tax revenues plunged $400 billion from 2008 to 2009 and failed to recover, remaining level in 2010. Federal government revenues were lower in 2010 than they were in 2000!

Prior to the Great Recession, maybe the government's debt problem could have been solved with some reductions in the major entitlement programs, cuts in war spending and tax increases on the wealthy. But now, even the most "austere" proposals for dealing with the budget crisis (such as those from Rep. Paul Ryan or Obama's deficit commission) do not come close to balancing the budget. They simply slow the pace at which the nation hurtles into debt.

It seems unlikely, in the current political climate, that the United States will take the necessary steps to restrain its profligate ways voluntarily, but at least the country still has the time and resources to do so. Greece, Ireland, Portugal (and now likely Italy) failed to get their budgets under control fast enough and effectively went bankrupt. Now the budget decisions for those countries are dictated by their financial patrons, the European Union and the International Monetary Fund.

So while parties wrangle over whether the wealthy should endure a small tax increase or federal spending should actually be reduced for the first time in most Americans' lifetimes, soon enough the topics of debate will be far more serious:

Should Social Security and Medicare be drastically reformed or eliminated? Should taxes be raised significantly -- and on everyone? How should the United States adapt, geopolitically, to a dramatically downsized military?

The nation's debt will require real sacrifice and tough decisions. America can make those decisions itself or, like Greece, Ireland, and Portugal, leave them to foreign creditors.

Isn't it time the nation's politicians

started taking this seriously?

Paul Daggett is an investment analyst in Minneapolis.